BANKRUPTCY ABCs FROM AN IMPUDENT LAWYER. I am a Worcester and Central Massachusetts bankruptcy lawyer. I do bankruptcy from all sides: commercial bankruptcies, consumer bankruptcies, and bankruptcy litigation. For most people (and lawyers), the ins and outs of bankruptcy law are scary and hard to understand. I know the law, I don’t scare easily, and I can explain it to you. This blog is your bankruptcy primer – delivered impudently and accurately. Licensed in MA & MA federal courts.

Chapter 13 is not just for consumers. An individual in a sole proprietorship (or who is engaged in some business activity, such as re...

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Tuesday, April 1, 2014

Now in Play: §506(d) "Strip-Offs" in Chapter 7

On March 31, 2014, the Supreme Court of the United States
denied certiorari in Bank of America,
N.A. v. Sinkfield, Petition No. 13-700. To put it in terms appropriate to
Major League Baseball’s opening day, this was the equivalent of Casey’s mighty
whiff at strike three in the ninth inning, with the bases loaded, a full count, and the chance
for a walk-off win.

The elements were all in place; a “rogue” circuit makes a
holding that three other circuits would not dare to make, on an issue that many
debtor lawyers fantasize about revisiting and that many banks dread like a recurring nightmare. The 11th
Circuit (albeit summarily, in an order) held that a fully unsecured second
mortgage lien could be “stripped off” a Chapter 7 debtor’s residence in Georgia,
when the value of that residence is only enough to (partially) secure the first
mortgage lien. The 11th Circuit based the order on its previous
(unpublished) decision in In re McNeal,
No. 11-11352 (11th Cir. 5/11/12), in which the circuit limited the Supreme Court’s
decision in Dewsnup v. Timm, 502 U.S.
410 (1992) to prohibiting the strip-down of partially secured first
mortgages in Chapter 7. The McNeal court held that fully unsecured second mortgages are fair
game to be stripped off under 11 U.S.C. §506(d), and relied on its own, pre-Dewsnup 1989 decision, Folendore v. United States Small Bus. Admin.,
862 F.2d 1537 (11th Cir. 1989), as precedent for doing so. The 4th
Circuit, 6th Circuit, and 7th Circuit (as well as many
lower courts) all reached opposite results in holding that Dewsnup v. Timm did apply and prohibited any lien stripping in
Chapter 7. Throughout most of the country, the old adage that liens float unaffected through a (Chapter 7) bankruptcy is alive and well.

Bankruptcy 101 on Lien-Stripping (in Chapter 7):

11 U.S.C. §506(d) seems clear on its face. It states
that:

To the
extent that a lien secures a claim against the debtor that is not an allowed
secured claim, such lien is void, unless --

(1) such
claim is disallowed only under section 502(b)(5)[as an unmatured debt for a
domestic support obligation] or 502(e) [as a contingent claim for reimbursement
or contribution] of this title; or

(2) such claim is not an allowed secured claim
due only to the failure of any entity to file a proof of claim under section
501 of this title.

Add to this §506(a)(1), which states that “An allowed claim
of a creditor secured by a lien on property in which the estate has an interest
… is a secured claim to the extent of the value of such creditor’s interest in
the estate’s interest in such property … and is an unsecured claim to the
extent that the value of such creditor’s interest … is less than the amount of
such allowed claim.”

Thus, under recent Supreme Court precedent, it seems like a “no-brainer”
to hold that the statutes say what they say: you determine secured claims according the
value of the debtor’s property (and we can fight about what that “value” is); there
is no secured claim or lien beyond the value of the property; the only exceptions to the lien-voiding rule
in §506(d) are certain unmatured and
contingent secured claims; and a creditor does not have to file a proof of
claim to have its lien determined as an “allowed secured claim”. After all, look at the unanimous decision last
month in Law v. Seigel, in which the
justices solemnly proclaimed that “’whatever equitable powers remain in the
bankruptcy courts must and can only be exercised within the confines of ‘the
Bankruptcy Code” and “We have recognized … that in crafting the provisions of§522, ‘Congress
balanced the difficult choices that exemption limits impose on debtors with the
economic harm that exemptions visit on creditors.’ … The same can be said of the limits imposed
on recovery of administrative expenses by trustees. For the reasons we have
explained, it is not for courts to alter the balance struck by the statute.” [1]

But - Dewsnup v. Timm

As many law school professors will gleefully tell you after you cite this straight-forward analysis –
we have the 1992 precedent of Dewsnup v.
Timm, in which the Supreme Court held that a partially unsecured first
mortgage could not be “stripped down” in Chapter 7 using these two statutes. The
pillars of that decision are as follows:

(a) Congress
could not have meant to change long-standing bankruptcy law that “that liens
pass through bankruptcy unaffected”, and courts do not look at a clean slate (with
no history) when interpreting Bankruptcy Code provisions;

(b) even though §506(a) and §506(d) both use the
term “allowed secured claim”, it is an ambiguous, undefined term, and does not
necessarily mean the same thing in each statute or elsewhere in the Bankruptcy Code;

(c) the function of §506(a) is to determine the
relative interests of secured creditors and debtors in property that is part of
the debtor’s estate, while the function of §506(d) is to void “only liens
corresponding to claims that have not been allowed and secured”; and

(d) if the Court were to hold otherwise, it would
ignore pre-Code bankruptcy practice and “freeze the creditor's secured interest
at the judicially determined valuation. By
this approach, the creditor would lose the benefit of any increase in the value
of the property by the time of the foreclosure sale. The increase would accrue
to the benefit of the debtor, a result some of the parties describe as a ‘windfall.’”

Dewsnup contains a
dissent authored by Judge Scalia, who – unsurprisingly – disagrees with the
majority’s decision because the plain language of both §506(a) and §506(d)
compels the voiding of the unsecured portion of the lien, notwithstanding
pre-Bankruptcy Code practice. Judge Scalia is still on the Supreme Court; one of the justices joining the majority,
Judge Kennedy, is also still on the Supreme Court. The rest of the participants
in the majority opinion – Judge Blackmun (the author of the majority opinion), Judge
O’Connor, Judge White, and Judge Stevens – have been replaced. So has Judge
Souter, who joined in Judge Scalia’s dissent. But Judge Thomas, who did not participate
in the decision and often joins with Judge Scalia, is still on the court.

So, all the conditions seemed right for a revisiting of
§§506(a) & 506(d): a split in the circuits; a (mostly) new cast of
characters on the Supreme Court; and a different perspective in recent
decisions of the Supreme Court on whether the plain language of the Bankruptcy Code or
the historical precedent of bankruptcy practice is more important. Yet, the petition for certiorari is denied,
and mortgagees across the country breathe a sigh of relief -- except, of
course, in Georgia, Alabama, and Florida, where motions and adversary
proceedings for lien-strip offs in Chapter 7 continue unabated[2].
Casey was expecting a fast ball on a 3
and 2 count, and got a curve ball instead, leaving the home crowd unsatisfied.

The practical effect is that a debtor’s attorney in the
First, Second, Fifth, Eighth, Ninth, or Tenth Circuit will have to take the
right case up for an appeal, and obtain a reasoned circuit decision on this
issue. The 11th Circuit has the outlier opinion already in In re McNeal – it’s just a matter of
finding an appeal with the right ingredients.

[1] Note also that the justices threw an earlier
Supreme Court case, Marrama v. Citizens
Bank of Mass., 549 U. S. 365 (2007) under the bus, ignoring that the Marrama court had blessed an equitable
exception to express statutory language, and then finessing the issue by saying
that another statute disqualified the debtor from converting his case to
Chapter 13.

[2] The NACBA’s amicus brief opposing the
certiorari petition likely gives the real reason for the order denying
certiorari: Bank of America “fast-tracked” the petition by agreeing that the 11
Circuit’s order was final, and deprived the Supreme Court of a “deliberative”
decision by a circuit court setting up a true conflict in the circuits on the
issue.

About Me

I am a 50-something year old attorney who lives and works in Worcester, Massachusetts. I concentrate my practice on bankruptcy (consumer, commercial and small business bankruptcy in Chapter 7, 11 and 13), with bankruptcy litigation expertise as well. I have also provided services to clients in commercial collections and litigation, general business consultation, and in residential real estate matters. In my varied career, I had stretches in which I foreclosed mortgages for mortgagees, wrote state and federal appellate briefs, and helped investigate and report on allegations of breaches of fiduciary duty and self-dealing by corporate officers and directors.

NOTE: I am licensed to practice as an attorney only in the Commonwealth of Massachusetts and in Massachusetts federal courts. NOTHING in my blog is intended to be specific or complete legal advice, and is for general information purposes only. If you think you need specific or complete legal advice from me - call me and set up a consultation. Finally - nothing in my blog represents the view of any person or organization other than myself. I wrote it, it's my view, and my content.

My interests outside of my practice include: being (an older) father to my two young sons; playing volleyball; performing on the community theater stage; and reading and watching sci-fi and fantasy (in my spare time). Big Game of Thrones fan here, way back to 1996. I can discourse on the BoSox, the Pats, or the Celts and seem like I know what I'm talking about. I also enjoy good food, good wine, good beer, and good company.